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New laws in several states require remote retailers, without a physical in-state presence, to begin notifying customers they own use tax and reporting customer sales to the state. In this article, Avalara's Scott Peterson discusses the new laws and the revenue and administrative burdens they may place on the states.
By Scott Peterson
Scott Peterson is the Vice President of U.S. Tax Policy and Government Relations for Avalara, Inc. In his role, Scott leads Avalara's effort to be the first name in sales tax automation. Prior to joining Avalara, Scott was the first Executive Director of the Streamlined Sales Tax Governing Board.
In 2016, a new tax law went into effect in Oklahoma, and this year similar laws go into effect in Colorado, Louisiana, Rhode Island, Vermont and Washington. These laws require internet and catalogue retailers that have no physical presence in these states – and therefore are not obliged to collect sales tax – to notify consumers that they owe the tax, which is now referred to as a “use tax” since the tax was not collected by the seller at the time of sale. The law also requires the sellers to send the sales information to the state's taxing authority, which includes name, address, date and total amount of purchase.
These laws don't actually change consumer tax obligations. Consumers in these states (and most other states) are currently required to pay use taxes – typically via their annual state income tax forms. But enforcement has been difficult and expensive because the states don't know how much is owed. The new laws are intended to remedy this by providing the states with the information they need (collected by the seller during the online purchase process) to validate the use taxes consumers pay.
On the surface, this may seem fairly straightforward, but like most tax issues, the context and the implications are very complex. In this case, the laws run counter to decades of precedent, and a Supreme Court decision was required to ensure their legality. The laws also have the potential to create havoc in other states.
The following discussion lays out the rationale and implications of the new laws.
The lack of data has long been the reason states give for not collecting use tax from consumers. Tax administrators often use “voluntary” to describe how a tax system works, but that assumes that by-and-large most taxpayers are law abiding citizens who voluntarily pay their taxes without the actual exercise of force. The “force” in a tax system refers to civil and criminal penalties attached to not paying. But forcing a person to pay isn't nearly as effective as imposing a legal obligation on a business to collect the tax on sales.
Think about the way income taxes work. Income, whether paid by an employer, a bank, or a mutual fund, is reported to the IRS pursuant to the force of federal law. The IRS uses that data to make sure taxpayers report and pay tax on all the income reported to the IRS. In turn, the IRS shares that data with the states, which use it to make sure taxpayers report and pay their full state income tax obligation. When the IRS audits a taxpayer, the IRS shares that data with the appropriate state, which uses that information to “audit” that taxpayer for state income tax compliance.
The IRS and states can effectively administer income taxes only because of the income data reported to the IRS. Even though almost all income tax is withheld by the entity paying the income, those who pay income and don't withhold the tax (e.g., businesses that pay consultants) still have a legal requirement to provide that data to the IRS.
Sales tax is different. Almost all sales tax is currently collected by a seller. As noted above, when sales legally go untaxed (e.g., internet purchases in most states from Overstock.com), the “use tax” is still owed, but the states have lacked any federal or state law requiring sellers to report sales data to the state governments. That lack of sales data makes it extremely difficult for a state to collect the tax without extraordinary effort.
For a state to collect use tax directly from a consumer, it must have the purchase data, a way to inform consumers that it has that data (e.g., a tax due notice), a way for the consumer to report and pay, and a way, if necessary, to apply force. When the five states noted above have their new laws in place and are receiving the sales data, a consumer's state income tax return is the perfect collection tool because it applies to almost all families and comes with a built-in enforcement process that can be tied to the new data.
Four of these five states already have a place on their income tax returns to report use tax. Washington is the exception.
For example, in Colorado, Line 14 of the state income tax return is where taxpayers report use tax. To know what amount of use tax to report, a Colorado consumer first completes Form DR 0104US. Currently, to report accurately, a consumer must keep track of their own non-taxed purchases, and must know their local sales tax rate.
In Oklahoma, Line 21 is for reporting use tax, and there is a handy use tax worksheet. On that worksheet are two options, one for those who keep track of their own non-taxed purchases and one for those who don't. For those who don't keep records, the amount of use tax owed is a set dollar amount that is a function of the taxpayer's federal adjusted gross income. Oklahoma also has this very ominous message that will become even more important once non-collecting sellers report non-taxed sales: “ Note: Your use tax worksheets may be reviewed. If it is determined that you owe more use tax than what is shown on your return, you may be subject to an assessment for the additional use tax.”
In Vermont, Line 27 is where consumers report their use tax. There is also a place to “certify” that no use tax is owed. In this setting, “certify” could be akin to perjury, and a dangerous box to check once the state starts getting purchase information from non-collecting sellers. Like Oklahoma, Vermont residents who don't keep track of purchase records can pay an amount that varies based on their adjusted gross income.
In Louisiana, Line 25 is where consumers report their use tax. Louisiana's consumer use tax form has lines a consumer may use to record their non-taxed purchases. Since their sales tax rate increased in the middle of 2016, their 2016 use tax worksheet is divided into two sections, one before the rate increase and one after.
For the four states with an income tax, once they receive the sales information from the non-collecting sellers, they will have the option of providing taxpayers with the amount of use tax due, thus eliminating the opportunity for intentional or unintentional misrepresentation and ensuring the maximum collection of tax revenue.
Now, a state without a personal income tax has adopted a notice requirement. Their ability to collect use tax directly from a consumer is more complicated. Since the state does not have an income tax to use to enforce their use tax, Washington's task is very complicated. The few people who pay use tax to the state submitted a use tax return. The state can compare those returns with the data submitted by retailers. The difficulty will be trying to understand the reasons why retailer sales data doesn't match a person's use tax return. It is more likely that the state will instead spend its time contacting those who never sent in a return.
While ensuring the collection of use taxes, the new laws have some important, potential implications. It isn't too hard to imagine that if states start collecting use tax from their citizens effectively and efficiently, sellers who currently collect sales tax will lobby state legislators to eliminate their collection obligation in exchange for sending sales data. However, many sellers today are required to remit their sales tax every month. Personal income tax returns are an annual event. A state's cash flow would be severely impacted if sellers reported sales instead of collecting the tax, unless the state created some form of monthly collection from consumers.
A shift to use tax collection would likely create another burden on the state. If the current sales tax were to be collected all as use tax from consumers, a state Department of Revenue would switch from getting tax from businesses (60,000-100,000 in a small state or 1,000,000 in a large state) to relying on consumers (500,000 in a small state to 35 million in the largest state). It is hard to imagine that many states would relish this new tax collection obligation. Further, it's much easier for consumers to absorb sales taxes that are paid a little at a time with each purchase. Seeing all that obligation as a single use tax amount on a yearly income tax return would likely cause tremendous dissatisfaction.
The new sales information reporting requirements are now a fact of life. Only time will tell if they successfully help the states collect use tax owed to them, or if there will be a ripple effect in other states and for other sales tax obligations. However, one thing is certain. Retailers of all types have a stake in the evolution of sales tax collection and should understand what the legislatures in their states are planning.
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